Contrarian guru David Dreman says the Federal Reserve has been playing a dangerous, unsuccessful game by keeping interest rates so low for so long. But he says there are ways for investors to cure the “easy money hangover.”
Inflation has been picking up lately, and in a recent Seeking Alpha column Validea CEO John Reese looks at how you can use the advice of Warren Buffett and Joseph Piotroski to keep your portfolio ahead of the inflation curve.
Could 2014 finally be the year that long-simmering inflation fears boil over? Wells Capital’s Jim Paulsen thinks it just might be.
“In the last five or six years we’ve been worried about nothing but deflation and weak growth,” Paulsen tells Yahoo Finance’s Breakout, “so it’s very difficult to imagine that we might get to a point where we’re worried about an overheated economy again, but I think we’ve got a shot at that (this year).”
Paulsen says a number of factors — a new dovish Federal Reserve chairman, tightening labor market, rising factory capacity utilization rate, rising commodity prices — could combine to trigger inflation fears. “If you put all those together I think that could cause people to worry about overheating or inflation,” he says. To be clear, though, Paulsen is expecting only a small pickup in inflation this year. But he thinks that slight pickup could trigger bigger fears.
Jeffrey Gundlach thinks interest rates will soon rise, but, unlike fellow bond guru Bill Gross, he doesn’t think inflation is upon us.
Gundlach, in a web seminar, recently said that a paradigm shift has occurred in the past five years or so, according to AdvisorOne. “Over the majority of the [past three decades or so] we’ve seen a benign inflation period characterized by stable to falling interest rates,” he said. “It’s quite likely interest rates will now rise and boost the returns of government instruments.” But, he added that inflation can’t occur without corresponding increases in median household income, and he says that is falling, AdvisorOne reports.
But Gundlach is concerned about global food price inflation. “Believe it or not, food is the real concern, especially in developing countries,” he said. “In these areas, 40% of a person’s income will typically go toward food. If it goes high higher, it will have an outsize impact, and riots and other forms of civil unrest could occur.” He also discusses debt, saying that developing nations are “now better fiscal stewards than developing countries”.
Top fund manager Mihir Worah of PIMCO says not to be lulled into complacency by the low inflation we’ve seen in recent years.
“We expect global inflation over the next three to five years — or even the next five to 10 years — to be higher than it has been over the last 20 years,” Worah says in an interview posted on PIMCO’s site. “While we do not expect double-digit inflation, we do see inflation gradually climbing higher than the close-to-2% core numbers that we have gotten used to in much of the developed world.”
Worah says two main factors lead him to that conclusion: First, the serious debt problem in developed countries will likely be solved only via inflation; and second, a booming middle class in the emerging world could well lead to a secular rise in global commodities prices.
Worah talks about why he thinks inflation will be higher in emerging markets than developed markets, and why significant differentiation could occur within Europe in terms of inflation levels. He also talks about how to hedge a portfolio against inflation, with the core tool being developed market inflation-linked bonds.
Hedge fund guru David Einhorn says he increased his bullish bets last month, but remains concerned about several issues, including the Federal Reserve’s low-interest rate policy.
In a conference call with Greenlight Capital Re investors, Einhorn said that he increased his bullish positions thanks to better-than-expected corporate earnings results, Bloomberg reports. But, he added, “This enthusiasm is tempered by our continued concern about the structural sovereign-debt problems in Europe and Japan, a slowing Chinese economy, and high oil prices and general inflation connected to the Fed’s continued insistence on maintaining an emergency zero percent interest-rate policy, which we believe is no longer useful or effective.”
Greenlight Re’s investment portfolio’s net-long position rose to 39% in April from 32% at the end of March, Einhorn said. He said he also added short bets in the first three months of the year as the market rallied, according to Bloomberg.
Last week, we highlighted a MarketWatch column that referenced a new study showing that stocks, against conventional wisdom, have actually served as poor hedges during periods of marked inflation. But a closer look at the study shows that that is far from the whole story.
The study was performed by Elroy Dimson, Paul Marsh, and Mike Staunton of the London Business School, who over the years have performed some of the most in-depth research ever on asset prices. Their latest effort looks at 19 different markets since 1900, examining how different assets performed during periods of “marked” inflation. They found that bonds — not surprisingly — get crushed in such periods, averaging a real return of -23.2%. Stocks, however, also struggle, they found, losing an average of 12% in real terms.
That sounds troubling, especially given how stocks are generally considered to be good inflation fighters. But if you look at Dimson, Marsh, and Staunton’s analysis (which is part of a Credit Suisse report), there’s a lot more to the story. For one thing, in their study, “marked” inflation signified inflation of at least 18% annually — a very steep figure that the U.S. didn’t even reach during the sky-high inflation of the late ’70s/early ’80s.
So how have stocks fared when inflation has been high, but not at that 18% mark? Well, according to the professors, when inflation has been between 8% and 18%, stocks haven’t fared great, but they’ve remained ahead of inflation, with 1.8% average annual real returns. Bonds, on the other hand, have averaged real annual losses of 4.6% in those periods. And, when inflation has run between 4.5% and 8%, stocks have produced annual real returns of 5.2%, while bonds have barely eked out a positive return.
Gold, meanwhile, has been a good hedge in those periods when inflation has been at least 18%, with real returns that were just in positive territory. In the 8% to 18% inflation range, gold has also outperformed stocks, with real returns of 4.4%. In that 4.5% to 8% inflation range, however, gold has produced real returns of just 2.8%.
But Dimson, Marsh, and Staunton warn against using inflation data as a timing signal, particularly since investors don’t know what the inflation rate is for a particular period until the period is over, and asset prices have already moved. “This is not a market timing tool,” they write. “High inflation may look like a sell signal, but our model is derived with hindsight and could not be known in advance; there is clustering of observations, so many of the signals may occur at some past date (e.g. the 1920s); and it is not clear where sales proceeds should be parked. In particular, real interest rates tend to be lower in inflationary times, the expected real return on Treasury bills will be smaller after an inflation hit, and other safe-haven assets like inflation-linked bonds are likely to provide a reduced expected return in real terms.”
Click here for a PDF copy of the professors’ report, which includes in-depth analysis of how inflation has impacted a number of asset classes over the past 112 years.